Bishop Estate
and the IRS have
confirmed an audit
of the trust

An IRS audit can be ‘ruinous’
to tax-exempt organizations

By Pete Pichaske
Phillips News Service

WASHINGTON - In a typical year, the IRS audits only a few thousand of the 1.2 million tax-exempt organizations doing business in the United States, and only a couple of dozen have their coveted tax status revoked.

But those figures are cold comfort for organizations targeted by IRS agents.

As speculation about the future tax status of Bishop Estate grows in Hawaii, experts on tax-exempt organizations interviewed here described an oversight process that, while spotty, can be unforgiving and ruinous to a charity.

It is a process that in recent years has brought down some well-known and hugely profitable organizations, from Jim and Tammy Baker's "PTL" Church, to a multimillion-dollar medical-services institution in Florida.

Both the IRS and the Bishop Estate have confirmed - but refuse to comment on -- an ongoing IRS audit into the $10 billion trust. But some familiar with both the estate and the IRS review process expressed little surprise over the crossed paths.

"I would guess that whatever IRS office oversees Hawaii has the Bishop Estate in its sights," said William J. Lehrfeld, a former IRS attorney now regarded as one of Washington's top tax attorneys specializing in non-profit organizations.

Like more than half the tax-exempt organizations in the United States, the Bishop Estate is classified as a 501(c)(3) organization, the most common of tax-exempt categories.

The benefit is huge: Such organizations pay no federal income tax, no matter how much money they earn.

But the classification carries with it two main requirements: the organization's managers cannot make an excessive amount of money off the charity's net earnings or assets, and the organization cannot engage in political activity. An infraction of either one can cost an organization its tax-exempt status.

Last year, Congress redrew the line. A law was enacted setting fines for anyone in a charitable organization who received excessive benefits, including "unreasonable compensation."

According to insiders, the "intermediate sanctions" rule was prompted by problems with some hospitals. But the Bishop Estate, whose trustees earn more than $800,000 a year, seemed to take it personally.

While the tax-exempt community generally supported the change, the Bishop Estate spent hundreds of thousands of dollars in a losing battle to oppose it.

Because the concept is still new, the IRS has yet to use intermediate sanctions. But Marcus Owens, director of the IRS' Exempt Organizations Division, said it is being pursued in "a couple" of cases.

Citing IRS policy, he declined to name the organizations.

Under the law, which is aimed at protecting a charity while penalizing the managers who made the mistakes, individuals are required to pay back the excess benefits they got -- plus a 25 percent tax.

Owens said high salaries "clearly" fall under the heading of unreasonable compensation. But he said "many, many variables" affect what would be considered unreasonable, including the individual's qualifications, how much time he puts in on the job and his effectiveness.

"The key is not the bottom-line net, but what he had to do to earn that money," said Owens.

Another key is extra benefits that managers might enjoy.

"It's not the salary they'll be worried about so much as the hidden benefits -- the use of a boat, say, or credit cards," said Lehrfeld.

In a typical year, said Owens, the IRS will audit 6,000 to 12,000 tax-exempt organizations. Two-thirds will be cleared entirely and with most of the others, only minor problems are found.

With most of the rest, the organization agrees to make a few changes and keeps its tax-exempt status.

But in about 20 to 30 cases a year, according to Owens, the IRS invokes its "sanction of last resort" -- revoking the tax-exempt status.

It's a long and painful process, often taking years to work its way through the court system, and it's generally avoided by the IRS.

"It's not our mission to close down organizations that help the community at large," explained IRS spokesman Sam Serio. "We don't do it too often."

What triggers such a drastic penalty? Typically, it is evidence of either political activity or of insiders getting private benefits, either in cash or fringe benefits, from the organization.

Those are the two biggest no-nos in the charity business, say tax experts, and lead to most of the revocations.

In one recent case, the IRS revoked the status of Branch Ministries, a religious organization that, during the presidential election, placed full-page ads in major newspapers urging the defeat of Bill Clinton.

"That one was pretty obvious," said Carolyn Wright, editor of the Exempt Organization Tax Review, a monthly journal on the tax-exempt business. "Political activity is a big issue."

Cases where individuals benefit from an organization are harder to prove, said Wright.

"They're usually more hidden," she said.

In a case still in the courts, the IRS revoked the tax-exempt status of LAC Facilities, a medical services organization in Miami.

According to the IRS, LAC bought seven medical practices for $17.4 million, then sold them to insiders for a $4.5 million note.

The IRS also found evidence of improper payments for "country club charges, catering services, liquor purchases, gift items and spouse travel," according to documents.

Despite the occasional, sometimes well-publicized revocations, not everyone in the business thinks the IRS keeps a close enough watch over charitable organizations.

"If there's an egregious problem called to their attention, they will look at it," said Robert Bothwell, president of the National Committee for Responsive Philanthropy, a watchdog group based in Washington. "But they're so understaffed in terms of exempt organizations, about the only time they look at anything is if it's called to their attention."

Tax attorney Lehrfeld believes every charitable organization should be audited at least once every 10 years.

"There's been very little accountability through the IRS for these guys," he said.

As it is, even wealthy organizations can go decades without an audit. It depends on their luck -- and their ability to avoid mistakes or headlines.

IRS officials say most audits are prompted by questions raised on annual forms filed with the agency. Audits are also triggered by complaints from insiders or news reports of potential wrongdoing.

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